“According to Standard & Poor’s, 29 members of the S&P 500 are scheduled to report this week and 98 next week. The consensus outlook is for 14% growth in earnings per share on a year-on-year basis from Q4 2017 and 17% from all of 2017, for the S&P 500’s members.
“If met, these growth rates would take US corporate earnings to all-time highs on a quarterly and annual basis. This helps to explain why US equities trade at record highs, too, but stock markets are forward-looking discounting mechanisms so any guidance given for 2018 will be more important than the 2017 numbers, especially as this will give some insight into how companies see the tax changes affecting them. For the record, Standard & Poor’s research sees a huge increase of 26% for 2018.
“When it comes to the company reports, there are six key issues to watch:
1. Are American companies going to pocket any earnings boost provided by the tax gain, or use it to cut prices and take global market share, especially as they also have a weaker dollar on their side?
2. If they do keep the extra income, are companies going to increase wages and spend more, to the potential benefit of the economy, or will they devote the extra cash to share buybacks, acquisitions and financial engineering? Apple has already promised to repatriate cash holdings from overseas, pay $38 billion in tax and invest in a new US campus. By contrast, Bank of America chief executive Brian Moynihan has stated that investors will directly receive the bulk of any tax windfall, via dividends and share buybacks.
3. Will consumers truly be better off under the new tax regime? Data from the Joint Committee on Taxation would suggest that there will be initial gains for all come 2019 but that by 2027 the benefits will be skewed toward those who are already better off (assuming new legislation has not been introduced by then):
4. Will the planned $1.4 trillion long-term increase in US government debt that will result from the tax cuts plan mean that US growth disappoints in the long term as the extra liabilities become an interest-bearing burden?
5. Will the tax cuts sufficiently rejuvenate growth in the economy and corporate earnings to justify the strong run in US equities witnessed since President Trump’s November 2016 election victory?
6. Will the tax cuts become so effective that the US Federal Reserve is forced into raising interest rates more quickly than expected, potentially negating at least some of the benefits, particularly for those who hold US financial assets? This remains a risk since it has historically taken an average of eight to nine rate hikes of one-quarter point each to stop US stocks in their tracks, looking at all of the Federal Reserve’s monetary policy cycles back to 1970. The US central bank is currently planning three interest rate increases in 2018, according to its dot-plot, and that would take the total to eight hikes in this up-cycle which began in December 2015.
“This suggests investors may need to be a little careful about what they wish for, especially as the US stock market looks expensive relative to its history.
“Using Professor Robert Shiller’s Cyclically Adjusted Price Earning (CAPE) multiple, US stocks have only been more expensive, post-war, on one occasion and was in 1999 - and the 2000-03 bear market soon followed. Pre-war, US stocks exceeded the current multiple in 1929 and it’s hard to think of a less encouraging precedent than that.”